Download study unit 12 - Together We Pass

STUDY UNIT 12
INVENTORIES
EVALUATION CRITERIA
Read pg 1 chapter 7
SCHEMATIC REPRESENTATION
study page 152
BACKGROUND
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Represents material portion of A of numerous entities
Valuation and disclosure has signif impact on afs and results of ops
Objective of standard is to prescribe:
- how cost of inventory is determined
- which useful and understandable info is provided in afs
Standard doesn’t apply fol categories:
- work in progress under construction contracts
- agricultural produce at point of harvest and biological assets
- financial instruments
Standard applies only partially to certain inventories, as measurement req don’t apply to:
* producers of agriculture and forest products, agricultural produce after harvest, minerals and
mineral products.
Are measured at net realisable value in well established practices and any changes in value is recog
in profit or
loss for period
* commodity broker-traders who measure inv at fair value less costs to sell, changes are taken to
profit or loss
Net realisable value is entity-specific amount realised from sale of inv in ordinary course of buss by
that comp
Fair vale less costs to sell isn’t entity-specific, and reflects amount for which same inv could b
exchanged between knowledgeable and willing buyers and sellers in marketplace
NATURE OF INVENTORIES
Inv incl all A, both tangible and intangible that:
 Are held for sale in ordinary course of buss, eg fuel at petrol station and sweets sold by a café
 Are in process of production for such sale
 Are consumed during production of saleable goods and services
 Incl cost of labour and other expenses
Decision if item is classified as inv or not, relates to its purpose to the entity
Ex 7.1 page 154
MEASUREMENT OF INVENTORIES
Inv is measured at the lower of cost and net realisable value
The measurement of inv for financial reporting entails following steps:
1. determining the cost
2. applying the cost allocation technique to measure the cost of inv
3. determining the net realisable value
4. recording the lower of cost and net realisable value in afs
COST OF INVENTORIES
INTRODUCTION
The historical cost of inventories includes:
 purchasing cost
 conversion costs
 other costs incurred in bringing inventories to their current location and condition
The costs of inventories excludes:
 abnormal spillage of raw materials, labour and other production costs during production process in
bringing inv to their current location and condition
 fixed production costs that aren’t allocated to production on grounds that normal capacity was used
as the basis of allocation. Portion not allocated is written off in soci
 storage costs, unless such costs are necessary in production process prior to a further production
stage
 admin expenses not related to location and condition of inv
 selling expenses
IAS 2 relates directly to inv and indirectly to cost of sales.
Thus although abnormal costs and under- or over-allocated overheads are excluded form the closing
inventory, they ar included in cost of sales
Example 7.2 on page 155
PURCHASING COSTS
These costs incl the foll:
 purchase price of finished goods or raw materials
 import duties and other taxes, other than those subsequently recoverable from the taxing authorities,
such as VAT fi the buyer is registered for VAT purposes
 transport costs
 handling costs
 other costs directly attributable to acquisition of inv
From these costs, the foll are deducted if included:
 trade discounts (cash and settlement discounts)
 rebates and other similar items such as subsidies on purchases
x 7.3 page 156
CONVERSION COSTS
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costs incurred in converting raw materials into finished products ready for sale
conversion costs incl:
- direct labour
- variable production overhead costs
- fixed production overhead costs based on normal capacity
defines normal capacity – production expected to b achieved on average over number of periods or
seasons under normal circumstances, taking into account the loss of capacity resulting from planned
maintenance
cost of normal spillage also forms part of conversion costs
ex 7.4 page 156
production process may sometimes produce 2/more products simultaneously, such as in a chemical
process. These are called joint products
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if costs of conversion of joint products cant b identified separately, a rational and consistent
allocation basis should b used
relative sales value of products, either at stage in production where they originate, or at the stage of
completion, may b appropriate
if production process results in main product and a by-product, the value of the latter is usually
immaterial
no cost is usually allocated to the by-product and the proceeds form the sale of these products are or
their net realisable value is deducted form the cost of main product
OTHER COSTS
Included in these costs are all other costs incurred in bringing the inv to the current location and condition.
Ex.:
 Costs of designing products for particular customer
 Borrowing costs relating to inventories where substantially long ageing periods are req, as in the case
of wine
 Necessary storage costs in production process
When comp purchases inv on deferred settlement terms and arrangement effectively contains a financing
element, that element is recog as interest expense over period of financing and is therefore not incl in cost of
inv
This element wud normally b diff between purchase price for normal credit terms and amount actually paid
for the inv
ALLOCATION OF OVERHEAD COSTS
Read pg 6.2
COST FORMULAS
Read pg 7
NET REALISABLE VALUE
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NRV is estimated selling price which could b realised in normal course of buss less estimated costs
to b incurred iot complete the product and to make the sale
Such estimates will take account of changes in prices and cost changes after the period under review,
in accordance with req of IAS 10 to extent that events confirm conditions existing at end of reporting
period
As determination of this value entails use of estimates, an element of judgement is involved and
caution shud b used when making use of estimates
Often difficult to determine NRV of product due to lack of info regarding costs necessary to make
the sale
In such cases, the current replacement value can b used as a possible solution
After having taken everything into consideration, estimates of NRV should b based on most reliable
info available at time of making the estimate
NRV
Estimated selling price in normal course of buss
Less: costs to make the sale, namely:
Costs to complete inv, trade and
other discounts
allowed, advertising, sales
commission, packaging costs,
transport costs
LOWER OF COST AND NET REALISABLE VALUE
Read pg 9.1
DISCLOSURE
Disclosure req regarding inv are prescribed by foll documents:
 IAS 2
 4th schedule to Companies Act, pg 29
Disclosure req are as follows:
 Accounting policy pertaining to measurement and cost formula used
 Total carrying amount of inventories in classifications suitable for comp, for ex:
- materials
- finished goods
- merchandise shown under appropriate subheadings
- consumable goods
- work in progress
- work in progress (construction work)
 Carrying amount of inv carried at fiar value less costs to sell, as provided by commodity brokertraders
 Amount of inv recog as cost of sales during period
 Amount of any write-down of inv recog as an expense in cost of sales
 If write-down is reversed in subsequent period, the amount reversed and circumstances which
resulted in reversal
 Carrying amount of any inv pledged as security
General
 Note that disclosure of carrying amount of inv carried at net realisable value is not required, but
amount of any write-doewn shud b disclosed, typically in note of profit before tax
 Disclosure of carrying amount of inv carried at fair value less costs to sell is req
EXAMPLE 7.21 ON PAGE 175 - NB